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Grabbing Your Interest

It may be of interest to you that a commonly missed deduction for taxpayers is interest. (That will be the only lame pun in this piece. I swear!)

What interest deductions are sometimes forgotten?

Car Loan Interest: For business owners, one often-overlooked deduction is interest on a car loan. Whether you deduct your actual car expenses or take the standard mileage rate, you are also entitled to claim a deduction for proportionate amount of interest on your auto loan for your writing business. For instance, if you drive 10,000 miles in a given tax year, 1,000 of which are business miles, and your car loan interest for the year is $500, you can claim an interest deduction of 1,000/10,000 x $500, or $50. The deduction in this example is small, but if you have a large percentage of business miles and/or a large car note, your deduction could be significant. Financial institutions are required to report your annual interest paid, so look for a statement in January.

Credit Card Interest: Credit card interest is another deduction business owners forget. Although interest on personal purchases is generally not deductible, interest on business purchases is. The IRS allows a deduction to businesses for supplies and other non-depreciable items in the year in which the items were charged even if the credit card debt is not paid off until a later tax year. The interest applicable to business purchases is deductible in the year in which the interest is actually paid. Credit card companies, too, are required to send a year-end statement showing the amount of interest paid, so be sure to keep it for tax purposes.

If you have a charge card you use for both personal and business purposes, it may be difficult to nail down exactly how much the interest charges were on the business portion of your charges. It’s simpler to have one card used strictly for business purchases so the end-of-year statement will provide the exact interest amount to deduct.

No-Interest or Below Market Interest Rate Loans: Think you got a great deal by buying a car, furniture, or other item on a zero-interest or low-interest loan? The IRS is a big buzzkill on these loans. According to Uncle Sam, in economic reality no lender makes interest-free or below-market rate loans. Per the IRS, the transaction actually involves a lower amount of principal than that stated in the purchase documents and includes “imputed interest” (a.k.a. “original issue discount”). The installment payments on the loan are treated for tax purposes as including an interest component.

Unless you are Good Will Hunting, the rules for computing the revised principal amount and the imputed interest could blow your mind. Talk to a tax pro if you have, or think you might have, a below-market interest rate loan. Those sadists among you can take a look at the discussion of original issue discount in Publication 535 “Business Expenses” on the IRS website, www.irs.gov.

And don’t forget, the depreciable basis of property purchased on a zero- or below-market rate loan will be the recomputed principal amount.

Personal Interest: As noted above, most personal interest is not deductible. A few items of personal interest are deductible, however, including mortgage interest on a personal residence, home equity loan interest on a personal residence, student loan interest, and investment interest.

These types of interest are subject to certain limitations and are reported in different places on the tax forms. Investment interest, for instance, is deductible only up to the amount of investment income, though the amount disallowed for a given tax year may be carried over to the next tax year. Investment interest is claimed on Schedule A. (See IRS Publication 550 “Investment Income and Expenses” for more details.) Student loan interest, on the other hand, is reported on page 1 of Form 1040 in the “Adjusted Gross Income” section. Student loan interest is subject to an annual maximum which is further reduced if the taxpayer’s income exceeds certain limits. (See IRS Publication 970 “Tax Benefits for Education.”)

Planning Tip: Because business interest is deductible and personal interest generally is not, you are better off charging business items rather than personal items if you have only a limited amount of cash with which to pay your expenses. For instance, let’s say you have only $100 cash. You need to buy both $100 in printer cartridges for your writing business and a $100 pair of booty-lifting jeans (after all, sitting in a chair all day writing isn’t great for the glutes). If you charge the jeans and pay cash for the printer cartridges, you’ll get no tax deduction for the credit card interest since the expense is personal. If you pay cash for the jeans and charge the printer cartridges, however, the interest on the charge would be deductible and thus reduce your taxes.

Likewise, if you have a large personal purchase to make and don’t have ready cash to pay for it, you may be better off taking a home equity loan rather than financing the purchase through another type of credit. While personal interest is generally not deductible, home equity loan interest generally is. Thus, you can turn a non-deductible interest expense into a deductible interest expense. Abracadabra! (See IRS Publication 936 “Home Mortgage Interest Deduction” for information about applicable limits.)

Diane Kelly’s debut novel, “Death, Taxes, and a French Manicure” will be released in September 2011. Sign up for her newsletter, full of tax tips and writing news, at www.dianekelly.com.

Should I Inc.?

Should I Inc.?

As both a writer and tax advisor, I’m often asked by authors whether it makes sense for them to incorporate their writing business. The answer is – it depends.

Writers have several options when choosing the form through which to operate.

A sole proprietorship is owned and operated by an individual, usually under the owner’s name, though the owner can register an “assumed name” for their business with their county clerk’s office.

Limited liability companies, a.k.a. “LLCs,” function with the flexibility of a sole proprietorship, yet have the advantage of also providing limited liability protection for business owners without the formalities required for corporations.

S corporations are small, closely held corporations, while C corps are often publicly traded and widely held. Both S and C corporations are required to have bylaws, hold shareholder meetings, and maintain extensive books and records to document corporate actions.

The simplest business form, and the one that makes sense for the vast majority of writers, is the sole proprietorship. However, some business owners choose to form a separate legal entity for their businesses in order to achieve limited liability protection or certain tax benefits. Beware, though. Business advisors have their own interests at stake. Often the primary result of forming an LLC or corporation is to generate fees for the advisor.

The Liability Issue. Despite lawsuits against writers such as J.K. Rowling and Dan Brown, legal action against writers is rare. Still, nobody wants to face the potential loss of personal assets. Forming a separate entity through which to operate a writing business can protect a writer’s personal assets from being seized to satisfy a judgment if the business is sued and loses the lawsuit. However, because forming and running an LLC or corporation costs more time and money than a sole proprietorship, a writer should seriously consider whether a real risk of liability exists before forming a separate business entity. In most cases, the risk of losing a lawsuit is negligible and forming an LLC or corporation isn’t worth the time and cost.

Tax Considerations. The income of LLCs and S corps is not subject to tax at the LLC or S corp level. An LLC with only one owner can report its income on a Schedule C just as if the business were a sole proprietorship. For S corps, a separate tax return must be filed (Form 1120S), but the form is an informational return only and no tax is paid with the return. Instead, the S corp’s income flows through to the shareholder’s individual income tax return, where it is reported on Schedule E and taxed at the individual income tax rates.

Unlike S corps, C corps are subject to tax at the corporate level. In some instances, the formation of a C corporation can save tax by permitting the division of income between the writer and the corporation and thus spreading income over the lower tax brackets for individuals and corporations. Unless the income of the C corporation is high enough, though, the cost of paying a professional to prepare the corporate tax return, as well as the costs associated with operating a corporation, may exceed any tax savings. Moreover, the writer would need to be paid a salary from the C corporation, which would require payroll taxes to be withheld and reported and a W-2 to be issued to the writer at year end. Thus, in many cases, the formation of a C corporation would unduly complicate matters and impose additional expense on the writer. What’s more, the income of a C corporation whose primary income is from royalties may also be subject to “personal holding company tax,” which is a 15% tax in addition to the income tax. A tax pro would need to examine a writer’s specific financial situation to determine whether forming a C corp makes sense.

Writers should also be aware that for state income tax purposes, the formation of a separate legal entity may subject their income to additional taxes the writers may avoid by operating as a sole proprietorship. Thus, forming a separate legal entity can backfire tax-wise, resulting in additional taxes and filing requirements and taking up more of the writer’s precious time and money.

The Bottom Line. The bottom line is that in the vast majority of cases it’s best to operate as a sole proprietorship. But if your writing is high stakes or high income, you should consult your legal or financial advisor to determine if forming a separate entity is right for you.

Diane Kelly’s debut novel, “Death, Taxes, and a French Manicure,” will be released in Sept. 2011.  Sign up for Diane’s newsletter, full of tax tips and writing news, at www.dianekelly.com.

Year-End Tax Tips for Writers

‘Tis the Season for Year-End Tax Tips

 Timing can be everything, especially when it comes to taxes.  Here are some year-end tips to help you reduce your 2009 federal income taxes:

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